More than 30 wineries, mostly in Napa and Sonoma counties, have been targeted in a wave of IRS audits of inventory accounting methods that have been common in the industry for three decades.
IRS auditors are claiming that some wineries are defining their inventory pool “items” under the dollar-value last-in, first-out (LIFO) cost-flow assumption too broadly, resulting in an inaccurate internal inflation index for a given vintner and a “distorted” reflection of income to be taxed, according to a nationally known wine accounting expert.
“If you have a regular Cab and you have a Reserve Cab with longer aging and more expensive packaging, but you treat them as the same wine, you will overstate your LIFO tax benefit,” Greg Scott, a partner with PricewaterhouseCoopers in San Francisco, told the North Bay Business Journal.
LIFO first was accepted seven decades ago for most accurately reflecting net income for industries with rapid inflation in pricing for inputs, and the wine business started using it about 30 years ago.
For businesses heavily affected by inflation, such as the cost of premium winegrapes in recent years, LIFO provides a way to defer taxes.
The trouble is, if a winery defines its pool items too broadly — common items can be as general as “bulk wine” and “case goods” — the IRS can require use of the Bureau of Labor Statistics inflation index, according to Wendy Petersen, senior tax manager in Moss Adams’ wine practice in Santa Rosa.
“If a high-end winery calculates a $5 million reserve and the [bureau] index calls for a $1 million reserve, then the winery would have to recognize $4 million as income, unless an alternate calculation was settled upon,” she said. “That would be a huge hit in bad economic times.”
And such a tax adjustment could topple some wineries, according to Kevin Alfaro, a partner in the St. Helena office of G&J Seiberlich & Company.
“It could actually bankrupt some wineries at a time when there already is financial pressure,” he said.
On top of this would be added record-keeping requirements for the more specific cost items.
These accountants are part of a group of more than 30 wine-focused and other accountants from about a half-dozen firms seeking an industry resolution on LIFO with the IRS, similar to what was brokered for the automobile and oil industries, without big audit adjustments. The local network of wine accountants started discussing options when the IRS audit notices went out April 10.
